Clear Eyed Capitalist

ForProfit v NonProfit Fundraising

A frequent question in the arena of social enterprise is what legal structure to be: for-profit, non-profit or hybrid? The question is sufficiently confusing that Criterion Ventures has been successfully touring the country for over a year hosting day-long “Structure Lab”s to give folks some tools sort out the issues. I took one and found it practical and helpful. One of the issues to think about is fundraising – where will your funding come from and what are its constraints? That may put constraints on your structure. While folks in your lab may be helpful beyond that, note: they don’t give specific legal advice at the workshop. So let’s walk that through informally now: earned revenue can go either way; any structure can take debt; equity returns require a for-profit. A tax-writeoff can be interesting – if there’s a non-profit intermediary willing to take expenditure responsibility (and your organization legitimately accomplishes a 501c3 compatible purpose) it could be possible to be a for-profit and get support from someone who wants to make a donation, definitely if that donation is to a community development loan fund who turns around and loans to the for-profit.

Perhaps you see how the hybrid model can get squishy, particularly when there’s a non-profit raising funds and contracting with a for-profit. A dear reader got me started on this post (Thanks Tony!) with an article from today’s NYT “Hybrid Model for Nonprofits Hits Snags”. That article talks about how GlobalGiving, a non-profit, had a for-profit subsidiary called ManyFutures Inc, that was trying to provide a technology platform to GlobalGiving and commercialize it. In this instance, the founders (who founded both organizations) lost money on the for-profit. Since they didn’t benefit at all it’s difficult to suggest they benefited unfairly. Still, close relationships raise the spectre of private inurement: “providing excessive benefit to a person who is close to or has a controlling interest in a nonprofit — though tax law says nothing about how much is too much”, according to the NYT. Periodically the media has raised the issue of “too much” – Minnesota Public Radio came under fire in the early ’90s because of high salaries at its for-profit subsidiary which handled the retail side of public radio. Dan Palotta, created the for-profit Palotta TeamWorks, and raised millions for charity by organizing sporting events (and earning revenue for doing so) until he came under fire for personally profiting too much. He’s written a book about how he believes the charitable model is broken, called “Uncharitable”.

So in the boom time, we got to see what happens when hybrids do well – we raise the issue of “how well is too well?” Now in the bust the NYT questions if hybrids are particularly vulnerable to failure. Are they? Are social mission enterprises in general? Getting away from hybrids, why choose for-profit vs non-profit for an earned revenue social mission? The current wisdom seems to be that it’s easier to raise money for a for-profit than a non-profit, especially when you’re looking at big dollars. People will commit more when they’re self-interested. Kevin Doyle Jones (also quoted in the NYT article) used to talk about “two-pocket thinking” -the investment pocket and the charitable pocket. In my experience consistently the investment pocket is bigger. The current economy raises another possible factor…

I’m feeling very aware of how many for-profits (not necessarily mission-related) I’m invested in are themselves largely charitable enterprises right now- many companies are losing money in this economy and we investors are ponying up in the hope of making good on our existing investments. Losing money and struggling to find traction for the business model like Many Futures, Inc doesn’t seem unique to hybrids or social enterprises to me. Maybe the biggest difference between these social enterprise models and for-profits is that when we donate to a non-profit, or even invest but with low return expectations (and therefore somewhat charitably) in a for-profit, we “write it off” both mentally and literally at the time of the investment, so it doesn’t have the lure of… I’ll call it “Salvag-ation”. In the for-profit investment where we hoped (or planned) to reap a reward, our difficulty in recognizing sunk costs and our hope of an eventual recovery perhaps keeps prior investors coming back to prop up a flagging enterprise through a couple extra difficult years. Perhaps that commitment, intentional or not, is what gives for-profits an edge in building a sustainable revenue stream. In fact, that reminds me of a quote I first heard during the Long Term Capital Management days though I see now it’s attributed to J. Paul Getty: “If you owe the bank $100 that’s your problem, if you owe the bank $100 million, that’s the bank’s problem”. In a for-profit, financial self-interest binds us together.

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🙂 Nice one, Shaula! I particularly like the focus on the difficulties of capital formation for donor-supported nonprofits even when economoic times are good, and the insight that our individual expectation of getting an economic return from our initial investment may well affect our tenacity, as a group, in supporting an organization’s mission in difficult circumstances. So the question for successful but financially struggling nonprofits is how can they describe their return in a way that inspires their key donors to feel personally invested in seeing the organization through the rough patch. Keep those insights coming!